AP Microeconomics Factor Markets — Worked Answer Explanations

Unit 5 · 12 questions explained

Below is a complete answer key for our AP Microeconomics Factor Markets practice questions. For each question you'll find the correct choice, a full written explanation of how to get there, and — for every wrong answer — a short note on exactly why it's tempting and where it goes wrong. Reading these straight through is one of the fastest ways to find the gaps in a unit before exam day.

Prefer to test yourself first? Take the timed Factor Markets practice test and come back here to review, or head back to the Factor Markets unit overview.

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Question 1 · Easy
A firm sells output in a competitive market at a price of $\$ 5$ per unit. The marginal product of the 4th worker is 20 units. What is the marginal revenue product (MRP) of the 4th worker?
- A
  $4
  Why not A: $4 would result from dividing the price by the marginal product, not multiplying. MRP = P × MP.
- B
  $20
  Why not B: $20 is the marginal product in units of output — not the monetary value. MRP multiplies MP by the output price.
- C
  $100Correct
- D
  $25
  Why not D: $25 r es u l t s f r o ma dd in g p r i ce an d ma r g ina l p r o d u c t ($ 5 + $20), not multiplying them.
Explanation
Marginal revenue product (MRP) measures the additional revenue a firm earns by hiring one more unit of labor: $M R P_{L} = M P_{L} \times M R$ . In a competitive product market, $M R = P$ , so $MRP_L = MP_L \times P = 20 \times \$ 5 = $100$ . MRP is the firm's demand for labor: the firm hires workers as long as $M R P_{L} \geq W$ (the wage).

Key takeaway
$MRP_L = MP_L \times MR_{output}$; for a competitive seller, $MRP_L = MP_L \times P$.
Question 2 · Easy
In a competitive factor market, the equilibrium wage is determined by:
- A
  The minimum wage legislation set by the government.
  Why not A: The minimum wage is a price floor that may or may not be binding. The equilibrium wage in a competitive market is set by supply and demand, not legislation.
- B
  The intersection of labor supply and labor demand curves.Correct
- C
  The wage at which firms maximize their total wage bill.
  Why not C: Firms maximize profit, not their wage bill. The competitive wage emerges from market clearing, not from firms optimizing a wage expenditure target.
- D
  The average productivity of all workers in the economy.
  Why not D: Wages reflect the marginal revenue product of labor at the margin, not the economy-wide average productivity. Supply and demand interactions in each specific labor market determine wages.
Explanation
In a competitive labor market, many buyers (employers) and many sellers (workers) interact. The wage adjusts until the quantity of labor demanded equals the quantity supplied — the intersection of the labor demand curve ( $M R P_{L}$ ) and the labor supply curve. At this equilibrium wage, every worker willing to work at that wage finds employment, and every firm willing to pay that wage can hire the desired number of workers.

Key takeaway
Competitive labor market: equilibrium wage = intersection of $S_{labor}$ and $D_{labor}$ ($= MRP_L$ curve).
Question 3 · Easy
A profit-maximizing firm in a competitive labor market will hire workers up to the point where:
- A
  The marginal product of labor equals zero.
  Why not A: Hiring until MP = 0 would mean the last worker adds no output — the firm would be over-hiring since the wage (> 0) exceeds the MRP.
- B
  The wage equals the marginal revenue product of labor.Correct
- C
  Total labor cost is minimized.
  Why not C: Total labor cost is minimized by hiring zero workers — an absurd outcome. Profit maximization balances marginal revenue and marginal cost of labor.
- D
  Average revenue product equals the wage.
  Why not D: Profit maximization uses marginal analysis — the firm equates marginal cost (wage) with marginal benefit (MRP), not average revenue product.
Explanation
The profit-maximizing labor hire condition mirrors the output market rule ( $M R = M C$ ). In a factor market: hire labor until $W = M R P_{L}$ . When $W < M R P_{L}$ , hiring one more worker adds more revenue than cost — profits increase. When $W > M R P_{L}$ , the worker costs more than they generate — reduce employment. Equilibrium: $W = M R P_{L}$ .

Key takeaway
Firm hires labor until $W = MRP_L$. The $MRP_L$ curve is the firm's demand curve for labor.
Question 4 · Easy
Which of the following would increase the demand for labor in the market for construction workers?
- A
  An increase in the wage rate paid to construction workers.
  Why not A: A wage increase is a movement along the labor demand curve (reducing quantity demanded), not a shift of the curve itself.
- B
  A decrease in the price of new homes in the housing market.
  Why not B: Lower output prices reduce MRP = MP × P, shifting labor demand left — firms hire fewer workers when the output they produce is worth less.
- C
  An increase in demand for new housing construction.Correct
- D
  An increase in the productivity of new construction machinery, substituting for workers.
  Why not D: If machinery substitutes for workers, the demand for labor shifts left. If machinery complements labor (raising MP), demand could shift right — but the question specifies substitution.
Explanation
Labor demand is a derived demand — it depends on the demand for the output workers produce. An increase in demand for new housing raises the price of homes, which raises the MRP of construction workers ( $M R P = M P \times P_{o u tp u t}$ ). Higher MRP means firms are willing to hire more workers at any given wage — the labor demand curve shifts right. Changes in output prices and productivity shift the labor demand curve; wage changes cause movements along it.

Key takeaway
Labor demand shifts right when output product prices rise, worker productivity rises, or when substitute capital becomes more expensive.
Question 5 · Easy
Which of the following would shift the labor supply curve for nurses to the right?
- A
  An increase in nurses' wages due to rising hospital revenues.
  Why not A: A wage increase causes a movement along the labor supply curve (more workers willing to supply at the higher wage), not a shift of the curve.
- B
  A government subsidy for nursing education that lowers training costs.Correct
- C
  An increase in the wages paid to physical therapists, an occupation with similar training requirements.
  Why not C: Higher wages for substitute occupations make nursing relatively less attractive, causing workers to move toward physical therapy — shifting the nursing labor supply curve left, not right.
- D
  A decrease in the overall population of working-age adults.
  Why not D: A smaller working-age population reduces labor supply in all markets, shifting the nursing supply curve left.
Explanation
The labor supply curve for a specific occupation shifts when non-wage determinants change: population, wages in substitute occupations, tastes for the job, and the cost of training or entry. Subsidizing nursing education lowers the investment required to enter the field, making nursing more attractive at any given wage — more potential nurses enter the market, shifting the supply curve right. A wage change moves along the existing supply curve; it does not shift it.

Key takeaway
Labor supply shifts right with: lower training costs, more workers, taste changes favoring the job, or lower wages in substitute occupations.
Question 6 · Easy
In a perfectly competitive factor market, a firm can hire as many workers as it wants at the market wage. This means the firm's labor supply curve is:
- A
  Upward sloping because the firm must pay more to attract additional workers.
  Why not A: An upward-sloping labor supply is what a monopsony faces. A competitive firm takes the wage as given and can hire any number at that wage.
- B
  Perfectly elastic (horizontal) at the market wage.Correct
- C
  Perfectly inelastic (vertical) because the firm requires a fixed number of workers.
  Why not C: A perfectly inelastic labor supply would mean the quantity of labor is fixed regardless of the wage — that describes a fixed factor, not the competitive firm's labor market.
- D
  Downward sloping because higher wages discourage workers from seeking employment.
  Why not D: A downward-sloping labor supply would imply fewer workers are willing to work at higher wages — the backward-bend applies at very high individual wages, but a competitive firm's supply is horizontal at the market wage.
Explanation
A firm operating in a competitive labor market is a wage taker — like a price taker in the output market. The market wage is determined by the aggregate supply and demand for labor. Any single firm can hire as many workers as it wishes at the prevailing market wage without affecting that wage. From the individual firm's perspective, the labor supply curve it faces is perfectly horizontal (elastic) at the market wage $W^{*}$ . This is analogous to a competitive firm facing a perfectly elastic demand for its output at the market price.

Key takeaway
Competitive firm in the labor market = wage taker; faces a perfectly horizontal (elastic) labor supply at the market wage.
Question 7 · Medium
A monopsony in the labor market is characterized by:
- A
  A single seller of labor who can set the wage above the competitive level.
  Why not A: A single seller of labor would describe a union (monopoly seller). A monopsony is a single buyer of labor — the 'mono' refers to the demand side, not the supply side.
- B
  A single buyer of labor who pays a wage below the competitive level.Correct
- C
  A market with many employers competing to hire the same workers at a single wage.
  Why not C: Many competing employers describe a competitive labor market — wages are determined by market forces, not by a single buyer's wage-setting power.
- D
  A labor market with a government-imposed wage ceiling below the competitive rate.
  Why not D: A wage ceiling is a government policy tool (price ceiling). Monopsony is a market structure where a single employer has market power over wages.
Explanation
A monopsony is a market with a single buyer (here, a single employer). Because the monopsonist is the only buyer of labor, it faces the upward-sloping market labor supply curve. To hire one more worker, it must raise the wage — not just for the marginal worker but for all existing workers (assuming no wage discrimination). This means the marginal factor cost (MFC) of labor exceeds the wage. The monopsonist maximizes profit by hiring where $M R P = M F C$ , resulting in a wage below the competitive level and fewer workers hired than in a competitive market.

Key takeaway
Monopsony: single employer faces upward-sloping labor supply; MFC > W; pays below competitive wage and hires fewer workers.
Question 8 · Medium
Compared to a competitive labor market, a monopsonist will:
- A
  Hire more workers at a higher wage.
  Why not A: A monopsonist restricts employment to exercise market power and pays a wage below the competitive level — both employment and wages are lower, not higher.
- B
  Hire fewer workers at a lower wage.Correct
- C
  Hire the same number of workers but at a lower wage.
  Why not C: The wage reduction under monopsony accompanies a reduction in employment — the firm moves along the upward-sloping supply curve, hiring less at a lower wage.
- D
  Hire fewer workers at the same wage as the competitive outcome.
  Why not D: Under monopsony, hiring fewer workers means moving to a lower point on the labor supply curve — which corresponds to a lower wage, not the same competitive wage.
Explanation
A monopsonist sets $M R P_{L} = M F C_{L}$ , where $M F C > W$ (because hiring more workers raises wages for all workers). The profit-maximizing employment level is lower than the competitive equilibrium. Once the employment level is determined, the firm pays the wage on the labor supply curve corresponding to that quantity — which is below the competitive wage. Both employment ( $Q$ ) and the wage ( $W$ ) are below the competitive benchmark, creating deadweight loss in the labor market.

Key takeaway
Monopsony equilibrium: fewer workers hired + lower wage than competitive market; sets $MRP = MFC$, reads wage off supply curve.
Question 9 · Medium
When a new technology significantly raises the marginal product of all workers in an industry, the most likely effect on that labor market is:
- A
  The labor supply curve shifts right, increasing employment and reducing wages.
  Why not A: Technology raises the productivity of workers, which affects the demand for labor (via MRP), not the supply of labor.
- B
  The labor demand curve shifts right, increasing both wages and employment.Correct
- C
  The labor demand curve shifts left as firms need fewer workers to produce the same output.
  Why not C: While technology might reduce the labor needed per unit of output, rising marginal product raises MRP — firms want to hire more workers (not fewer) at any given wage.
- D
  The equilibrium wage falls because each worker is now producing the same output more cheaply.
  Why not D: Higher MP raises MRP, which increases what firms are willing to pay for labor — wages rise, not fall.
Explanation
Labor demand is derived from $M R P_{L} = M P_{L} \times P_{o u tp u t}$ . When technology raises marginal product, MRP increases at every employment level — the labor demand curve shifts rightward. With labor supply unchanged, the new equilibrium has both higher wages and higher employment. This is the standard result: productivity improvements benefit workers through higher wages in competitive labor markets. The demand for labor rises because each worker now generates more value for the firm.

Key takeaway
Higher worker productivity (higher MP) shifts labor demand right → higher wages and higher employment in equilibrium.
Question 10 · Hard
The labor supply curve for an individual worker is often described as backward-bending because:
- A
  At all wages, higher pay causes workers to prefer leisure over work.
  Why not A: At low wages, higher pay causes workers to supply more labor (substitution effect dominates). The income effect outweighs substitution only at higher wage levels.
- B
  At sufficiently high wages, the income effect outweighs the substitution effect, causing workers to work fewer hours.Correct
- C
  Workers always prefer the minimum socially acceptable wage to maximize leisure time.
  Why not C: Workers do not uniformly prefer minimum wages. Individual labor supply decisions depend on the trade-off between consumption (requiring income) and leisure at each wage level.
- D
  Higher wages reduce worker productivity, causing firms to demand less labor over time.
  Why not D: This confuses effects on labor demand with the shape of the labor supply curve. The backward bend is a supply-side phenomenon driven by income vs. substitution effects on individual workers.
Explanation
Each wage increase has two effects on an individual worker's labor supply: (1) Substitution effect — leisure becomes more expensive (each hour of leisure costs more forgone wages), so the worker substitutes work for leisure → supply more hours. (2) Income effect — higher wages mean the worker can achieve target income with fewer hours → work less. At low wages, the substitution effect dominates and quantity of labor supplied rises with the wage (normal upward slope). At high wages, the income effect can dominate, causing the supply curve to bend backward (quantity supplied falls as wage rises).

Key takeaway
Backward-bending labor supply: at high wages, income effect > substitution effect, causing workers to supply fewer hours.
Question 11 · Hard
When a firm has market power in both its output market (monopoly) and input market (monopsony), how does this affect labor hired compared to the competitive benchmark?
- A
  The firm hires more workers than the competitive benchmark because it can price its output higher.
  Why not A: Both monopoly power in output and monopsony power in input markets reduce employment below the competitive level — the firm restricts both output and labor input.
- B
  The firm hires fewer workers than the competitive benchmark due to market power on both sides.Correct
- C
  Employment is unchanged because the monopoly output effect and monopsony input effect cancel each other.
  Why not C: Both effects work in the same direction — both reduce employment. There is no offsetting mechanism.
- D
  The firm pays a wage above the competitive rate to attract workers away from other industries.
  Why not D: A monopsonist pays below the competitive wage, not above it. There is no rival employer drawing workers away in a monopsony.
Explanation
With monopoly power in the output market, $M R < P$ , so $M R P_{L} = M P_{L} \times M R < M P_{L} \times P$ . The labor demand curve lies to the left of the competitive case. With monopsony power in the input market, $M F C > W$ , and the firm hires where $M R P = M F C$ , further restricting employment below the already-reduced monopoly level. Both market power sources independently reduce employment and create welfare losses. The wage paid remains below MRP — workers are exploited on both margins.

Key takeaway
Monopoly output power lowers MRP; monopsony input power drives MFC above wage — both independently reduce employment below competitive levels.
Question 12 · Hard
A minimum wage set above a monopsony's profit-maximizing wage can potentially:
- A
  Decrease employment because higher wages always reduce the quantity of labor demanded.
  Why not A: In competitive markets, a minimum wage above equilibrium reduces employment. In a monopsony, a minimum wage in the right range can increase employment — the standard competitive logic does not apply.
- B
  Increase both employment and wages simultaneously.Correct
- C
  Have no effect because the monopsonist sets wages independently of government policy.
  Why not C: A binding minimum wage directly constrains the monopsonist's wage-setting ability, changing the effective labor supply curve the firm faces.
- D
  Cause the monopsonist to exit the market due to unsustainable labor costs.
  Why not D: A minimum wage set between the monopsony wage and the competitive wage need not push the firm to exit; it may simply shift the equilibrium closer to the competitive outcome.
Explanation
In a monopsony, the profit-maximizing wage is below the competitive wage, and employment is below the competitive level. If a minimum wage is set above the monopsony wage but below the competitive wage, it effectively makes the labor supply curve flat (horizontal) at the minimum wage for the relevant range. This eliminates the incentive to restrict employment (since MFC now equals the minimum wage for additional hires up to the supply curve). The result: the firm hires more workers than before and pays higher wages — both improve simultaneously. This is the key counterintuitive result of monopsony analysis.

Key takeaway
In a monopsony, a minimum wage set between the monopsony wage and the competitive wage can raise both wages and employment simultaneously.